China's Great Ball of Money Is Rolling Back Into Commodities

In China, money flow is tightly controlled and capital markets are relatively underdeveloped, meaning the economy works like squeezing a balloon.

You press it in one place, and it bulges in another. Policy-maker moves to cool one expansion only serve to inflate another.

Now that "gyration of bubbles," according to Société Général SA’s chief China economist Wei Yao, has been heating up the commodities market again.

Earlier this month, thermal and coking coal futures hit a record high since their debut in 2013 while zinc soared to the highest since 2011. Steel rebar, nickel, tin, iron ore and rubber futures also climbed to multi-year highs.

It's also interesting that buyers are piling in to get their hands on more obscure commodities such as glass, which is traded on the nation's futures exchanges, and garlic.

Data compiled by the Commerce Ministry in Beijing shows the price of the bulbs soared to record high or 14 yuan per kg, a rise of more than 80 percent from a year-ago.

Glass futures in Zhengzhou ran up to the highest in more than two years on Nov. 11 amid heavy trading.

Fundamental issues of declining supply and rising demand are partly to blame, but market watchers reckon that an uptick in trading volumes smacks of speculation, likely nudged by tightening measures in property markets.

"It's possible that some of the money is coming out of housing markets, especially from the first- and second-tier cities where tightening measures have been imposed to curb the property bubble,” said Aidan Yao, senior emerging Asia economist at AXA Investment Managers, in an interview.

Despite slowing wider economic growth, real-estate prices of China's top-tier cities have climbed very quickly in the last few years. Shenzhen, for example, saw home prices skyrocketing as much as 60 percent just in the past year.

In an attempt to cool the rally, Beijing rolled out new measures in October to more than 20 — mostly top-tier — cities where property prices have disproportionately rallied.

"Garlic could be one of the target markets for speculators because there hasn't been a supply-and-demand change dramatic enough to warrant such a big price spike,” said AXA Investment’s Yao.

The country's ball of hot money has also been making its way back to bonds markets, less than a year after the home-buying frenzy almost drove the bond "bubble" to a collapse. "Despite no substantial monetary easing, bond yields have been falling until recently, which is a clear sign that a lot of the money has gone into fixed income markets as well," said Yao at AXA Investment.

He added that the recent development is a "mirror image" of post-equities meltdown over the summer last year. "When the stocks market collapsed, the housing market became the magnet for capital and now commodities is a popular destination," he said.

SocGen’s Yao agrees, saying that “the wall of liquidity and the dynamics are still there.” But this time around, she cautiously raises a red flag on such a rapid price rally in the commodities.

"These are the signs that Chinese policy makers should take note of because this indicates that inflation pressure at some point in the financial system or in the housing market will spill over into the real economy,” she said.

A persistently rising CPI will be a “straitjacket” on the People's Bank of China next year, giving a serious conundrum to the central bank in terms of its policy direction next year.

“Although that’s our risk scenario, if that happens, it becomes a very tricky question for PBOC whether they should ease or tighten their monetary policy,” said SocGen’s Yao.

To the senior economist at AXA Investment, it's not yet "alarming" for overall price levels due to “problems of overcapacity” in sectors where inflationary fears are high.

"Fast commodities price rally, to the extent that it is driven partly by speculation, does bring some financial risks. But for inflation, unless it is driven by a structural demand-supply imbalance, it should not pose an alarming risk,” he said. "The support for a persistent price run-up is still very weak at the moment."